Borrowing against a 401(k): a very bad idea


As the threat of foreclosure continues to mount for many homeowners, the temptation to borrow against a 401(k) increases. Very bad idea, yet one that occurred to 13-19% more 401(k) holders in 2007. A recent article in CFO Magazine details a few of the ugly scenarios that can result.

Yes, many companies offer loan programs as part of their 401(k) programs as an incentive to get employees to participate. Employee loans against 401(k) balances are bad for both employers and employees. Not only is it a huge administrative headache for employers, but employees often get caught if their are any discrepancies or inaccuracies in the amortization schedule for repayment. Like the IRS will care that someone in the HR department made a mistake. The employee is solely responsible for any and all payback irregularities.

One of the advantages of participating in a 401(k) program is to take advantage of the free money from matching employer contributions as well as compound interest on contributions. Neither of these advantages occur when an employee stops making new contributions and merely repays the borrowed amount. Problems mount exponentially if an employee loses his or her job while owing money against the 401(k) balance. Just when the employee is most at financial risk, the outstanding amount must be repaid in full or the IRS will consider the loan or withdrawal as ordinary income and tax it accordingly. There is a 10% penalty if the borrower is under age 59 1/2.

The IRS does allow for hardship withdrawals from a 401(k) to avoid foreclosure of a primary residence, but the long term savings consequences are staggering. A 5 year, $8,200 loan can have a $62,000 impact on the 401(k) bottom line. Cutting expenses, renegotiating with creditors, getting a second job, are just a few of the much better alternatives for financially strapped homeowners.

Increase your money and finance knowledge from home

Introduction to Preferred Shares

Learn the difference between preferred and common shares.

View Course »

How to Avoid Financial Scams

Avoid getting duped by financial scams.

View Course »

TurboTax Articles

Video: Tax Guidelines About Gifting

Note: Some of the content of this video applies only to taxes prepared prior to 2012. It is included here for reference only. Find out the tax guidelines about gifting with help from TurboTax in this video on tax tips.

Video: What are Income Tax Rates?

Note: The content of this video applies only to taxes prepared for 2010. It is included here for reference only. Income tax rates change depending on both the amount of money you make and how you made it. Find out about income tax rates with help from TurboTax in this video on tax tips.

Video: How To Reduce Errors on Your Tax Return

Did you know that errors on your tax return can affect the amount of your tax bill and the amount of time it takes to get a refund? Fortunately, TurboTax helps you avoid errors AND be sure you're getting all the tax deductions and credits you deserve.

Does Your Company Need to File Form 1095-B?

A company is responsible for filing IRS Form 1095-B only if two conditions apply: It offers health coverage to its employees, and it is "self-insured." This means that the company itself pays its employees' medical bills, rather than an insurance company. A company that doesn't meet both conditions won't have to deal with Form 1095-B. Its employees might still receive a 1095-B, but from their insurer, not the employer.

Video: Who Qualifies for an Affordable Care Act Exemption (Obamacare)?

The Affordable Care Act requires all Americans to have health insurance or pay a tax penalty. But, who qualifies for an Affordable Care Act exemption? Find out more about who qualifies for an exemption from the Affordable Care Act tax penalty, how to claim an exemption on your tax return and how the Affordable Care Act may affect your taxes with this video from TurboTax.

Add a Comment

*0 / 3000 Character Maximum